When filling out an investment portfolio, investors can turn to exchange traded funds to gain broad, diversified exposure to various assets in the U.S. and around the world.
ETFs have become an increasingly popular way to access markets due to their easy accessibility, cheap costs and passive exposure to widely observed benchmark indices.
“It’s happening because the markets have become more efficient,” Gabriel Pincus, president of GA Pincus Funds, told U.S. News. “It’s very hard to outperform an index these days. Years ago when spreads were wider and information moved more slowly, it was easier and people could outperform the index. Now that everyone has the same information, it’s very difficult.”
Anthony D. Criscuolo, a certified financial planner and portfolio manager with Palisades Hudson Financial Group in Fort, pointed out that ETFs provide more tax efficiency than most traditional open-end mutual funds. Moreover, some mutual funds have high investment minimums, whereas investors can buy and sell 1 ETF share at a time if they so choose.
However, since ETFs trade on an exchange like any common stock, potential investors should be aware of the indirect costs, such as commissions and bid/ask spreads.
“While some investors assume ETFs will always be cheaper than mutual funds, this is not necessarily the case,” Criscuolo said. “In addition to the expense ratio, investors should carefully consider the other costs of each type of fund. It’s just as important to pay attention to an ETF’s brokerage fees as it is to understand a mutual fund’s load, if any, and other fees.”
Eric Hutchinson, a managing director at United Capital, also argued that ETFs offer more control to investors over when to buy and sell based on the investment vehicle’s self-directed structure.
Active mutual funds may incur capital gains at times that may or may not be advantageous for the individual investor. John H. Foard III, CEO and founder of Foard Wealth Management, told U.S. News that he had seen clients receive 1099 tax forms for capital gains on investments they never saw and lost money on the fund. In contrast, investors will not realize any capital gains on an ETF until they sell.
For more information on ETFs, visit our ETF 101 category.